Download Choose the right valuation method for your business

Choose the right valuation method for your business
If you’re looking to sell your company, to attract investors or simply to find out your net worth, it's
important to obtain an accurate valuation of your business. There are several ways to do this, each
with its own advantages and risks. Here's a look at how to conduct a business valuation, and the
biggest pitfalls to avoid.
Gather all of the information you need
For an objective and accurate valuation, start by gathering as much information about your business
as possible. The type of information you need will depend on which valuation method you choose.
If your valuation will be based on assets, you need to do a complete audit of both tangible assets
(such as buildings, employees, cash and machinery) and non-tangible assets (such as goodwill or
intellectual property). You must also list any liabilities – that is, anything that subtracts from the
business’s value, such as debts or legal rulings.
For a valuation based on business earnings, you need detailed financial information such as cash
flow statements, debts, annual turnover and profit and loss statements – ideally dating back at least
three to five years.
Potential buyers or investors will want to know whether your business will make money in the future.
Including all information, such as sales reports and forecasts, customer profiles, marketing plans and
competitor analyses, will make the process more transparent.
Consider the valuation method
As with a valuation of any asset, the big challenge in valuing a business is reconciling what you think
the business is worth and what a buyer may believe it's worth. The true value of your business is the
amount someone is willing to pay for it.
Let’s look at the two most common ways that experts determine a business’s value.
Asset-based valuation
This method adds up the value of the business’s assets and subtracts its liabilities. It takes into
account tangible assets such as cash, equipment and property. It should also include any intangible
assets – that is, non-physical items that also generate revenue, such as goodwill and intellectual
property.
Goodwill can include anything from the location of the business to brand recognition, staff
performance and the number and quality of customer relationships. Liabilities are items such as bank
debts and payments due.
An asset-based valuation is often used when the business has underperformed and goodwill is low.
Whatever the case, it's important that your valuation doesn’t overvalue your business assets, as it can
bring unwanted attention from government regulators. The Australian Securities and Investments
Commission (ASIC) is now publicising audit results that uncovered irregularities in financial reporting.
This has resulted in asset write-downs across a number of high-profile companies.
Valuing business assets is often a complicated process, guided by the valuer's past experience in
selling and evaluating businesses in the same industry.
Earnings-based valuation
If your business is expected to grow, a prospective buyer will be interested in both its existing assets
and any profits it will generate. There are two popular methods for valuing a business in this context:

Return on investment (ROI): also referred to as capitalised future earnings, this considers the
annual ROI a buyer can expect from the business after purchasing it. For example, if the
business is generating profits of $100,000 per year and is offered for sale at $500,000, the
ROI associated with the sale is 20 per cent.

Earnings before interest and tax (EBIT): This is where the business's annual earnings before
interest and tax are multiplied by a number based on its expected future profitability and
growth potential. For well-established businesses that have shown consistent solid
performance, this multiple might go as high as six – so a business with an EBIT of $200,000
might sell for as high as $1.2 million.
Every industry has its own formulas and rules of thumb for calculating a business’s current market
value. The Australian Bureau of Statistics (ABS) can be a valuable source of information for checking
the reliability of these valuation methods.
Cash flow and other considerations
It’s important to remember that income and cash flow are not the same. How quickly do your
customers pay their bills, relative to outgoing expenses? If your earnings look good on paper but cash
flow is a problem, this must be factored in.
Another consideration is the impact of change of ownership. If you left the business tomorrow, could a
new owner maintain the critical customer relationships and processes? In other words, how much of
the business is inseparable from its current owner? This could apply to any number of key people who
work in the business.
Finally, does technological disruption have the potential to affect your business's value? Most
companies can update their systems and processes to keep up with the latest technologies. In some
cases, however, losses are inevitable – cloud computing, for example, has affected many traditional
hardware and software businesses.
Want to know more?
No business valuation method is perfect, and it's worth remembering that your business is worth
whatever someone is prepared to pay for it. Whatever you decide, getting expert advice is essential –
and that's where we can help. Speak to us today to clarify your situation and make sure you’re
working from up-to-date advice and information.
Thomson Reuters Tax & Accounting